Published: 2023-06-14T19:35:24.000Z
Fed Hawkish Pause
Senior Economist , North America
Director of Research , Macroeconomics and Strategy
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Bottom line:The Fed skipped hiking at the June FOMC meeting, but the signal was clear that core PCE inflation remains too elevated and additional tightening will likely be required. We see a further 25bps hike at the July FOMC and then a final 25bps increase at the November meeting to a peak of 5.50-5.75%. In 2024, core inflation will likely come down further and allow some Fed easing, but we would forecast 75bps with a soft landing for economic growth rather than a recession.
Figure 1: Fed March Summary of Economic Projections (SEP)
Source: Fed (June SEP)
More Tightening Before 2024 Rate Cuts
The June FOMC statement and Fed Chair Powell Q/A provide a number of clues on prospective policy tightening. Key points include
- Inflation/Growth Slowdown. Largely as expected FOMC officials median for 2023 GDP and core PCE inflation were revised upwards (Figure 1), but the revisions were marginal for the economic picture for 2024/25. Still the median of 1.0% GDP in 2023 versus the prior median of 0.4% makes it feel like officials have accepted momentum in the economy should be enough to avoid recession. Fed Powell in the Q/A pointed to some signs of better balance in demand/supply in the labor market including lower vacancies, higher participation for over 55’s and slower wage growth. Even so, Powell overall assessment is that the labor market is tight and with projections seeing a soft landing for growth, the labor market is unlikely to get slack with current policy. In reference to core PCE inflation the Fed chair did note that not much progress has been made in the last 6 months and the trend remains well above 2%. Re credit tightening after the spring regional bank crisis and CRE slowdown, the Fed chair noted them as points of focused but appeared less concerned than March or May FOMC meetings.
- Guidance on Interest rates. The 2023 median dots are consistent with close to two further 25bps hikes from the Fed in 2023, with 12 out of 18 members projecting at least two hikes (with the normal caveat that this includes non-voting members). In the Q/A, Powell wanted to leave the impression that the tightening bias remains in place and did not soften the 50bps suggested by the dots for remaining tightening in 2023.
- July and September/November meetings. Fed Powell did clarify that a decision had not occurred for the July meeting, but that it would be a live meeting. With only one set of key data by the July 26 meeting, the odds are towards a 25bps hike in the Fed Funds target. Our core PCE inflation forecast is slightly higher than the Fed’s projection and thus we are revising our view to add in a 2nd hike to a 5.50-5.75%. Whether it is September 20 or November 1 is not an easy call and for now we pencil in November with a further skip at the September FOMC meeting.
- 2024 rate cuts. The dot median for end 2024 Fed Funds is 100bps below the end 2023, which suggests that the Fed is looking to reduce the degree of restrictive policy. With core PCE inflation projected to fall to 2.6% in 2024, the Fed would still be keeping the real policy rate high but avoiding it increasing further by cutting the Fed Funds target (Powell confirmed this idea in the Q/A). However, we remain concerned that the labor market will not soften enough to get core inflation down enough to trigger this scale of cuts and we are penciling in 75bps of cuts in 2024 to end 4.75-5.00% and then 100bps in 2025. Given that the economy will still be growing, it could be difficult for the Fed to be too aggressive in 2024 unless the lagged effects of Fed tightening are more powerful than the Fed or Continuum Economics project.